How is a bonus issue different from a stock split?

Hi there ,

Most readers seem to have some confusion about whether bonus issue and stock splits are the same or not.   They may appear to be the same especially in the eyes of a person not well-versed in finance. But they are, in fact, two different things. This article will help you to get a clear picture of the difference between the two.

WHAT’S THE DIFFERENCE?

Simply put- A bonus is a free additional share. A stock split is the same share split into two.

Usually companies accumulate it’s earnings in reserve funds instead of paying it to share-holders in form of dividend. This accumulated reserve fund is then converted into share-capital and allotted to share-holders as bonus shares in proportion to their existing holding. So, Share-capital of the company increases with a concomitant decrease in its Reserve profits. Share-holders get bonus shares in compensation of dividend.

But when a share is split, say, from Rs 10 denomination to Re 1 denomination, there would neither be an increase in the share capital nor a concomitant decrease in the reserves of the company. This is because while in a bonus issue a person having one share of Rs 10 face value would get another share of the same face value should the company go for a 1:1 bonus what would happen in a stock split is his one Rs 10 share would now be converted into ten Re 1 shares.

WHY DOES A COMPANY ISSUE BONUS SHARES?

One of the major reasons why companies declare bonus issues is that a higher number of shares improves float and liquidity and thereby traded volumes of the stock. A lower price also makes the stock seem more affordable to small retail investors, who might otherwise give it a miss at high price levels. Another aspect of a bonus issue is that it reflects the confidence of the company in its ability to service a larger equity base. Thus, bonus issues are said to be a good signaling mechanism on the company’s capacity to deliver future benefits to shareholders in terms of increased dividend.

Not all is positive with a bonus issue. In some cases, a bonus share ploy is used by companies to mask flagging performance and to perk up sentiment.

  • For example, a company has an authorized share capital of Rs. 1,00,000. It has issued 10,000 shares with a face value of Rs. 10 each. Thus, its issued share capital is also Rs. 1,00,000.It has an accumulated reserve of Rs. 10,00,000. It decides to issue bonus shares in the ratio of 1:1 or “1 for 1” – that is, 1 bonus share for each share held. In this case, it transfers Rs. 1,00,000 from its reserves to its authorized share capital. Thus, its reserves come down to Rs. 9,00,000, and its authorized share capital increases to Rs. 2,00,000.Using this new share capital of Rs. 1,00,000, the company issues 10,000 new shares, each having a face value of Rs. 10, and gives a new share – the bonus share – for each share held. Its issued share capital also goes up to Rs. 2,00,000.

HOW DOES BONUS SHARE AFFECT INVESTORS?

Immediately, It doesn’t affect your investments anyway. Post the bonus, the share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the share holder. However, more often than not, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.So, when stock prices move up in the long run, there will be dramatic increase in the wealth you’re holding.

WHY DOES A COMPANY SPLIT IT’S STOCK?

The primary reason is to infuse additional liquidity into the shares by making them more affordable. It needs to be reiterated here that the shares only appear to be cheaper, though it makes no difference whether you buy one share for Rs 3,000 or two for Rs1,500 each.

HOW DOES IT AFFECT YOU?

It is like cutting an eight-inch pizza into 12 slices from four slices before. But if you want to buy the shares of a company which are frightfully expensive, you can now buy them for less. Except for that , in a stock split,  fundamentals about the company does not change, the issued share capital remains the same, the revenue remains the same, and the profit remain the same too! But, since the number of shares issued increases, the profit per share (or the Earnings Per Share – EPS) decreases by the same factor.

  • So, if EPS is Rs. 15 per share for a share having a face value of Rs. 10, after a 10:1 stock split, the EPS would come down to Rs. 1.5. But since you would be holding 10 shares now, your share of EPS remains the same: Rs. 1.5 * 10 shares = Rs. 15, which is as before!

So, if the PE of the stock is 20 in our example, the price would go down from Rs. 300 (EPS of Rs. 15 * PE 20 = Rs. 300 per share) to Rs. 30 (EPS of Rs. 1.5 * PE 20 = Rs. 30 per share). But again, since you would be holding 10 shares now, your actual holding remains the same: Rs. 30 * 10 shares = Rs. 300, which is as before!

So, there is absolutely no change anywhere, except for the number of shares traded!

WHY DOES MARKET CHEER STOCK SPLITS?

Stock market interprets a stock split as a statement of confidence by the company – it interprets a split as a signal from the company that it is confident about its future growth. Also, a stock split increases the number of shares traded in the market, which increases liquidity.These factors are considered positive, and therefore the market reacts positively!

TAX IMPLICATIONS

Bonus shares- As far as tax is concerned, since no money is paid to acquire bonus shares, these have to be valued at nil cost while calculating capital gains. The originally acquired shares will continue to be valued at the price paid at the time of acquisition. An incidental tax planning benefit is that since the market price of the original shares falls on account of the bonus, there may arise an opportunity to book a notional loss on the original shares. This is known as bonus stripping. The Indian Income-Tax Act has introduced measures to curb bonus stripping.

Stock splits – As far as the tax implications for stock splits are concerned, well, there aren’t any. A stock split, like a bonus issue, is tax neutral. However, when the shares are sold, the capital gains tax implications are different that what is applicable for bonus issues. Here, the original cost of the shares also has to be reduced. For instance, if the cost of the 100 shares at Rs 1,500 per share was Rs 1, 50,000, after the split the cost of 500 shares would be reduced to Rs 300 per share, thereby keeping the total cost constant at Rs 1, 50,000.

CONCLUSION

So, if you are an investor in the company, you have reason to celebrate when you get a bonus. But don’t celebrate when your company splits stock. It’s is just a technical change in the face value of the stock. But if you want to buy more shares, it is good news because now, you will be able to afford them or at least get them cheaper!

Bye for now. Have a nice day !

You may like these posts:

  1. Bonus shares – A positive sign.
  2. Benefits of owning shares
  3. How does news affect stock prices?

34 Responses to “How is a bonus issue different from a stock split?”

sheru

April 29, 2011 at 10:41 pm

Dear Sir
thanks for this , now i have no confusn on this matter.

lalje

August 13, 2011 at 10:58 pm

too good

Dividends vs Bonus | Basics of Share Market

October 28, 2011 at 8:27 am

[...] How is a bonus issue different from a stock split? [...]

Kayli

November 3, 2011 at 2:45 pm

No question this is the place to get this info, thakns y’all.

Jaspal Singh

November 29, 2011 at 3:51 pm

This article about Bonus Issue is not entirely correct. In case of bonus issue the total market capitalisation remains the same after the bonus is issued as it was before. Hence the cost of the new alloted shares and the existing shares held should be adjusted.
e.x. if a person held 100 shares at Rs1000 before a 1:1 bonus issue then after the bonus issue he will be having 200 shares at Rs1000 only and not Rs2000.

J Victor

December 1, 2011 at 4:45 pm

Hi,

Market capitalization = Current stock price x number of shares outstanding.

It’s clearly written that post bonus the share prices fall in proportion to the bonus issue implying that the market capitalization remains the same.

Elizabeth M

February 4, 2012 at 12:55 pm

Nice post. I was checking continuously this blog and I am impressed! Very useful information specifically the last part :) I was seeking this particular information for a very long time. Thank you and best of luck.

Roshni Bhatia

February 19, 2012 at 12:40 pm

Very well explained article on the basic differences between bonus issue and stock split. Common Investors tend to get confused between the two and fail to understand its impact on the company’s performance and the market price. Your article clearly explains the above.Thanks for sharing. All the best.

ANR

March 1, 2012 at 2:05 pm

price of each share decreases proportionally in both cases. So to an investor both are equivalent in terms of total value of his holdings in that stock. Only difference I understand are in the way tax calculations are shown (again here, the overall tax implications seem to be the same).
As an investor should I care about factors other than share price, its liquidity (again, with corresponding effect on share price). Things like Share capital, Profit reserves matter only to the extent they directly impact current share price….. no?
Am I missing something?

Vince

April 4, 2012 at 7:01 am

Greeting from over the ocean. precise post. I will return for more.

miriama

June 4, 2012 at 11:41 am

hey thank you… well explained and very detailed ..vinaka from fiji

J Victor

June 4, 2012 at 7:08 pm

Thank you :)

hitchy

July 12, 2012 at 10:18 pm

Excellent detailed post to explain :)

rajeev

July 13, 2012 at 9:54 am

simple but elegant… thankyou..

hasintha

July 13, 2012 at 10:00 am

very precise explanation, thank you sir

J Victor

July 17, 2012 at 5:40 pm

thanku:)

J Victor

July 17, 2012 at 5:40 pm

thanks rajeev:)

Prasad

August 16, 2012 at 7:50 pm

What I conclude is Bonus Shares will enrich me after long holding and Split will help me in shorter term due to slightly faster growth in share price due to percieved less costs.

J Victor

August 19, 2012 at 10:24 pm

Hi prasad,

Your conclusion is right.

Nikhil sharma

December 22, 2012 at 1:44 pm

Hi Victor…
Thank u so much for giving me an information about the difference between both major terms. Now, my all doubts are cleared and I have no confusion about them

Hector

December 25, 2012 at 8:48 pm

Very informative and detailed.

indunil

January 25, 2013 at 7:17 pm

Well explained.

J Victor

January 27, 2013 at 1:43 pm

thanks

Vijay

February 6, 2013 at 5:49 pm

The article is good and simply explianed. Appreciate that.

I have the same feeling as ANR ..

price of each share decreases proportionally in both cases. So to an investor both are equivalent in terms of total value of his holdings in that stock. Only difference I understand are in the way tax calculations are shown (again here, the overall tax implications seem to be the same).
As an investor should I care about factors other than share price, its liquidity (again, with corresponding effect on share price). Things like Share capital, Profit reserves matter only to the extent they directly impact current share price….. no?
Am I missing something?

veerareddy

February 22, 2013 at 11:44 am

thank u victor for your brief explanation about stocks.

sammie

April 28, 2013 at 10:29 am

Having read this I believed it was really informative.
I appreciate you finding the time and energy to put this information together.
I once again find myself personally spending
a significant amount of time both reading and posting comments.

But so what, it was still worthwhile!

kayleigharrington

May 24, 2013 at 7:15 am

Very descriptive post, I loved that bit. Will there be a part
2?

MRM

May 24, 2013 at 11:50 am

Excellent explanation, Thanks

Devarajan

January 19, 2014 at 10:01 am

Simply nice explanation. thanks

yugandar

February 4, 2014 at 2:52 am

awesome victor ! Good One .

Simona

July 27, 2014 at 4:25 pm

Since I am new to this stream, I still am a bit confused so correct my understanding of the topic if I’m wrong…..when a company wants to issue bonus shares, they take from their accumulated reserves and then divide that amount into bonus shares which they give to their existing shareholders in proportion relating to their existing shareholding. From the company’s point of view, the price of the shares fall because the number of shares increase so technically, more people will be able to buy their shares due to the lower price. But the bonus shareholders on other hand don’t exactly get any “bonus” if you thing of it. Not only are the price of their shares falling but also the “bonus shares” that they are receiving is actually the dividend that is rightfully theirs. So why would they agree to getting bonus shares. If the value of 200 shares is the same as the value of 100 shares, what’s the point of conceding to a bonus issue of 1:1.
Btw, nice page….I did understand bonus issue a lot better relative to the other pages I visited :)

AP

December 5, 2014 at 8:45 am

Really useful..Thanks Victor.

Mike Simmons

April 7, 2016 at 3:24 am

In response to Simona’s post – you are correct Simona. Because the market value (share quantity x market price) of the investor’s holding is the same after the bonus issue as before it, there is no ‘bonus’ element in that the investor receives no additional value directly from the bonus issue. However, it could be argued that there is a long-term benefit for investors due to the fact there is (post bonus issue) a greater quantity of shares available in the market, therefore greater liquidity, making the shares easier to trade, whether to buy or to sell.

gautam

August 16, 2016 at 12:39 pm

Hey Victor,
Thanks for the wonderful Blog.
If my understanding is correct, Bonus issue gives of 1:1 gives you one free share for every share you own. You wrote – Post the bonus, the share price should fall in proportion to the bonus issue.So is it If your share was of 1000 Rs, you get 2 shares of 500 rs each or 1000 each ?
Also, Can you explain Infosys example. As i understand it issued a Bonus in 2015 , But how the stock price is affected I am not clear. Because the share price sudden variation is showing no change in Graph of last 5 years in Google Finance. Thanks

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